If you’re starting a new business, or getting more serious about an existing one, you might be wondering how to start an LLC or corporation.
Whether you’re looking for personal liability protection, or considering the tax benefits a corporation classification could provide, upgrading your business to an official business entity could be a smart choice.
According to the National Association of Small Business’s 2017 economic report, 35% of small business owners opt to form a Limited Liability Company (LLC), 33% choose to become an S-corporation, and 19% become a standard corporation. (1)
Creating an LLC or corporation can feel overwhelming, but by following a few simple tips, you can better understand which type of entity is right for you.
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Understand your options
There are a few key options to explore when you’re starting a new business or considering a new classification for your existing business.
The easiest forms of business structures to set up are sole proprietorships and partnerships.
- A sole proprietorship may be sufficient for a small business with one owner. The owner receives flow-through tax benefits, as revenue is considered the owner’s personal income and is only taxed once. There are also minimal regulatory requirements to abide by. One major limitation of a sole proprietorship is that the owner is legally considered to have the same identity as their business, leaving the owner personally liable for any debts or losses associated with the business. (2)
- A partnership is a business owned by two or more people, referred to as partners. Partners enjoy the same flow-through taxation benefits as a sole proprietor; however, they’re generally both liable for debts and losses incurred by the business even if they were not directly responsible for them. (2)
There are benefits to having your business recognized as a separate legal entity. If you’re interested in this option, LLCs and corporations might be right for you.
- Corporations are owned by shareholders. A corporation exists as a separate legal entity from its owners, protecting them from being personally liable for the corporation’s debts and losses. It’s a more complicated business structure to set up, with strict legal requirements to abide by, including regular board meetings and annual reports. A C corporation is the most common category, and is taxed as a business entity at the business tax rate (which is much lower than the individual tax rate). Then, owners are individually taxed on their profits. S corporations are only taxed once, but can only consist of up to 100 shareholders. (2)
- Limited liability companies (LLCs) combine elements of partnerships and corporations, making them a flexible choice for business owners. LLCs allow owners to choose whether they are taxed as a C corporation, or whether they want to retain flow through taxation benefits. LLC owners are called ‘members’, and an LLC can have as many or as few members as they like. Critically, LLCs are also considered their own legal entity, protecting owners from liability for business losses and debts. They’re also easier to set up and run than corporations. (2)
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Get your paperwork right
If you are creating a corporation or LLC, there is paperwork that needs to be filed to make it official.
If you are creating a corporation, the required paperwork is referred to as “articles of incorporation” or a “certificate of incorporation.” If you are creating an LLC, these documents are referred to “formation documents.” (3) (4)
When creating a corporation, your documentation will be a matter of public record, so keep in mind that any member of the public will be able to access it. (3)
Requirements vary from state to state for a certificate of incorporation, but you can expect to need the following information to form a corporation:
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- Your corporation’s name, usually including the moniker “corp,” “corporation,” “company” or “inc.”
- Your business purpose, explaining what your company does. Depending on your state, you may be able to use a general-purpose clause such as “all lawful business.”
- Stock information, such as how much stock the corporation is authorizing, and share par value.
- Stakeholder appointments, including your registered agent, the incorporator, and company directors and officers.
- Your corporation’s legal address is required in some states, but is optional in many. (3)
If you’re filing to create an LLC, your formation documents will generally consist of the following (although these may vary based on your local state requirements):
- Articles of organization, which is essentially the LLC version of a certificate of corporation. This should include your business name, purpose, address, and appointed stakeholders such as your agent and managers.
- An operating agreement is not required by law, but is highly recommended. Your operating agreement should include how business decisions will be made if there is more than one LLC member, which members own which percentage of the business, and any other important information such as how profits and losses will be divided.
- Employer identification numbers (EIN) should be used on all business-related documentation. You can get an EIN by filling out IRS form SS-4. (4)
Ensuring your documentation is correct is essential to avoid delays in your business status. A CPA or lawyer can help you file your documents, and there are many online formation services to consider, who can handle everything for you.
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Confirm an operating agreement
Although an operating agreement is not a legal requirement in some states, there are advantages to making sure your business has a watertight agreement signed by all members.
In a single member LLC without an operating agreement, your LLC will resemble a sole proprietorship and your personal assets may be at stake in the event of a financial disaster. (5)
Your LLC operating agreement is crucial in establishing limited liability, to protect your interests as an entrepreneur. (6)
Your LLC operating agreement should state who your members are, their ownership stakes, and how you will work together to make business decisions. (6)
Theoretically, without an operating agreement, one member could enter into binding, expensive contracts with vendors without the knowledge of other members, or otherwise jeopardize the company.
Your operation agreement should also outline how the LLC is funded, and how profits will be distributed among members. For instance, it would answer questions like: are profits and losses to be shared according to ownership stake? (6)
This document helps establish a shared understanding among members of how the business will work, and all members must sign the agreement to make it valid. (4)
Final Thoughts
In deciding which business entity is right for your needs, you must consider the benefits and pitfalls for each corporation.
By making sure you understand how each business classification can benefit you, ensuring you have the correct paperwork, and creating an airtight operating agreement, you can give your business the best chance of succeeding while enjoying the protections and benefits of your new entity.
